Vijay Kumar Gaba

 The localized lockdown and mobility restrictions in past 6weeks have led to scaling down of FY22 GDP growth estimates. The new estimates mostly imply that Indian economy may record marginally negative growth during two period from April 2020 to March 2022. These estimates though assume (i) No community transmission of infections; (ii) no nationwide lockdown; (iii) no wider shutdown of industries and construction work; and (iv) normalization of mobility restriction in 2HFY22. Any further worsening of pandemic situation may lead to further downgrade of growth estimates resulting in spillover impact over FY23 as well.

The global rating agency S&P, recently published a note saying, “The possibility the government will impose more local lockdowns may thwart what was looking like a robust rebound in corporate profits, liquidity, funding access, government revenues, and banking system profitability.” The note further stated that agency is “looking at two scenarios, both entailing a cut in its GDP growth forecast for India:

·         In a moderate scenario, new infections peak in May 2021. If that happens, the hit to India’s GDP growth is estimated at 1.2 percentage points, indicating that India’s GDP is likely to grow 9.8% in FY22 compared with 11% growth estimated previously.

·         In a more severe scenario, new infections peak in late June 2021. In this case, the hit is estimated at 2.8 percentage points, with growth of 8.2%.”

As reported by Bloomberg, the scenario projections by S&P assume that initial shocks to private consumption and investment filter through to the rest of the economy. For instance, lower consumption will mean less hiring, lower wages, and a second hit to consumption, the note said. The severe scenario, which assumes hits to economic growth and infrastructure sector cash flows, presents more downside risks. Leverage remains elevate.

Incidentally, the current estimates appear to assuming a fast normalizing developed world, and hence buoyant export sector and capital flows.

IMF has projected US and China economies to move beyond their pre-Covid levels in 2021 itself, led by sharp rise in both consumption and investment. Even EU that bore the brunt of pandemic in 2020, is expected to reach near pre-covid level in 2021. This essentially implies rising global inflationary pressures creating possibilities for an earlier than currently forecasted monetary tightening. The capital flows to emerging market may there get impacted, if these forecast come true.

What no one is forecasting is a re-lapse of pandemic in the developed world. Rationally, it does not look likely, given the speed of vaccination, development of preventive ecosystem and treatment protocols. However given that the virus is mutating itself fast, assigning zero probability to this occurrence in economic forecasts may not be fully appropriate. God forbid, if this happens, Indian economy may decline rather precipitously.

The government had surprised the markets by maintaining strict fiscal discipline in Union Budget for FY22. So far we have not heard any relaxation in budget estimates of fiscal deficit. However, any worsening of conditions from here may require another dose of fiscal stimulus. It is pertinent to note that the fiscal stimulus last year was mostly focused on capacity building and easing liquidity. The present conditions require strong social sector spending program, which primarily aims at cash handouts. The recent setback to the ruling BJP in UP local body elections and West Bengal assembly elections; and continuing farmers’ agitation may motivate the government to consider material cash subsidies to poor and farmer ahead of critical state assembly elections in UP, Punjab, Odisha, Goa and Uttrkhand. All these elections are due in February/March 2022.

Insofar as stock market is concerned, the consensus appears to be leaning towards the strategy that the localized lockdowns may not hamper the industrial and construction sector like 2020, as the government has spared the manufacturing and infrastructure activities from lockdown restrictions. The consumption may however get impacted materially. Cyclical over Consumers appears the preferred trade as of now.

More on this next week.

In the context of India stock markets, I found the following two things worth noting on Tuesday:

(i)    A number of brokerages wrote strategy notes urging the clients to use the recent “lockdown fear” led correction in stock prices as a good opportunity to buy stocks. Apparently, the strategy appeared to be driven by (a) deep fall followed by a sharp recovery in 2020; and (b) belief that the abundant global and local liquidity and low interest artes will continue to support equity markets for couple of more years at least.

(ii)   The IT sector stocks corrected rather sharply after the bellwether TCS announced a decent set of number for 4QFY21 and encouraging commentary for FY22. This highlights, in my view, that markets expectations may be running rather high in terms of corporate performance and payouts. There is virtually no margin for any disappointment on earnings or payout front.

Some research reports have taken note of the intensifying second wave of Covid-19 infection cases, and cautioned against the likely adverse impact of the incremental restrictions on mobility due to this. For example-

“The Economic data released yesterday showed that the restrictions & sporadic lockdowns in response to the fresh wave of coronavirus infections started impacting the overall demand & growth. The IIP contracted 3.6% for February 2021, mainly on account of a steep contraction in the manufacturing output. Meanwhile, India's retail inflation rose to a 4 month high of 5.52% in Mar (5.03% in Feb & 5.91% in Mar 2020) as food prices soared.” (Aditya Birla Capital)

“The sporadic lockdowns/mobility curbs & night curfews put in place across key economic hubs in India in the past few days are likely to cost the nation $1.25 bn/wk. Taking into account rolling COVID curbs, if the current restrictions remain in place until the end of May, estimate is that the cumulative loss of activity could amount to around $10.5 bn, or ~0.34% of annual nominal GDP. However, the impact on the Q1FY22 nominal GDP is likely to be higher, shaving ~1.4% from the same.” (Barclays Bank)

The Nomura India Business Resumption Index (NIBRI) dropped sharply to 90.7 for the week ending 4 April from 94.6 the prior week, ~9.3pp below the pre-pandemic normal. This is its steepest weekly decline since mid-April last year. Accordingly, Nomura has cut the 2021 GDP forecast for India to 11.5% from the earlier 12.4%.” (Nomura Securities)

It is pertinent to note that currently, Nifty valuations (one year forward PER) are at 15% premium to the long term (10yr) average; and the market consensus is expecting ~32% earnings growth in FY22 followed by ~18% growth in FY23. Obviously, the expectations are running high, leaving little room for any disappointment.

Even after the recent episodes of sporadic mobility restrictions impacting the business and consumer sentiments, and downgrade of overall GDP growth for FY22, the consensus earnings estimates have been cut by less than 2% for FY22.

In my view, we may see further downgrades in both macroeconomic growth and earnings growth estimates for FY22. I am not sure if market may be forced to de-rate the equities’ valuation by these downgrades, but any rerating would certainly be difficult.

Currently, market consensus appears to be working with Nifty EPS of Rs640-650 for FY22 and Rs750-770 for FY23. I would prefer to be somewhat conservative and work with Rs590-610 for FY22 and 680-700 for FY23.

This means, I may be mostly ignoring the benchmark indices and focusing on businesses which I found (i) reasonably valued; and/or (ii) having very high visibility of growth, in spite of Covid-19 related obstructions. Because the Lord has commanded that “Blessed are the meek: for they shall inherit the earth” (Bible, Mathew 5:5)